Educational Articles

Dow 30 Earnings: Cisco Systems- Fourth Quarter 2014

Kevin Downing
| August 14, 2014

The world's leading supplier of networking equipment, Cisco Systems (CSCO –Free Cisco Stock Report), has released fiscal fourth-quarter results (year ended July 26, 2014) that were in line with our expectations. Adjusted earnings per share of $0.55 came in a penny above our estimate, while revenues were flat year over year, versus our call for a slight decline. Although the industry bellwether was able to meet its estimates, it tempered investors’ expectations by providing revenue guidance of flat to up 1% in the current quarter.

Further, Cisco revealed its plan to eliminate 6,000 employees or roughly 8% of its workforce in the coming months. This would be roughly six times the number of layoffs in the recently concluded fiscal year. It's calling the restructuring a “reallocation of resources” because the plan entails reinvesting all of the cost savings into its most promising growth areas like data center, cloud services, software, and security. The move echoes similar decisions to cut jobs over the past several years, the most significant being in early 2011 when it overhauled its management structure to increase efficiency. Investors seemed none too concerned or surprised by the announcement and results, as the stock is only down marginally following the news. We think the restructuring provides evidence of the company's dedication to earnings growth.

Taking a look at product sales in the recently concluded period, the Routing unit saw its contribution to the top line drop 7% year over year, as continued double-digit growth from its high-end ASR 9000 device and strong demand from large Internet companies was offset by softness from optical and mobile customers.

The other core unit, Switching, fell 4% as demand for advanced devices on campuses continued to be weak, offsetting solid demand from cloud providers, financial services firms and technology companies. The sales team is trying to manage a transition from its Nexus 7000 product to the Nexus 9000, which is contributing to the lackluster performance.

Management was quick to point out its favorable positioning in the transition to software-defined networks or SDN, an area of concern for investors in recent quarters. In essence, SDN can simplify networks by separating the software that makes decisions about where traffic is sent from the underlying hardware that the data travels through. Thus, customers can avoid buying Cisco's “intelligent” routers and switches, buy less costly commodity type gear and use mechanisms, such as OpenFlow to control where data go. We think the concerns have some merit, but we are confident in the company's ability to stay ahead of technology transitions and view the notion that Cisco will be outmaneuvered in this growing space as unlikely. We think the worst case scenario is that the company will need to make price concessions, which would likely hinder margins (more below).

Meanwhile, Cisco continues to perform well in the data center space with 30% year-over-year gains thanks to continued strength from its Unified Computing System, which combines physical servers, virtualization software, and high-end switching gear and is now a $3 billion-a-year business. Cisco reported that it gained share for the 18th consecutive quarter and now commands the number two market share in blade servers worldwide.

Highlights from management's year-over-year product order presentation (Cisco's preferred indicator of performance) include overall growth of 1%, with 17% and 16% gains from U.S. commercial and enterprise customers, respectively. Further, U.S. service provider orders dropped 9%, Europe, Middle, East, and Africa grew 2%, and Asia-Pacific fell 7%. China was a particular problem, falling 23%, which we think is largely due to price competition from competing firms like Huawei.

We think this trend, coupled with a mix shift, contributed to the highly-scrutinized product gross margin falling 110 basis points sequentially to 60.3%. Notably, the service gross margin was as strong as ever at 66.8%.

The company is not expecting a significant improvement in demand from emerging markets or service providers. This contributed to its lackluster non-GAAP guidance for the October period of $0.51 to $0.53, which is below our prior call of $0.55. In response, we are shaving a nickel from our fiscal 2015 earnings estimate, reducing it to $2.10 a share.

Overall, we were not thrilled with Cisco's performance in the quarter or near-term outlook. That said, the company does appear to be doing what it can to stay competitive and maintain earnings momentum over the long haul. We think this well-run telecom giant will be able to successfully maneuver upcoming technology transitions, and its shares remain a quality choice for conservative income-oriented investors looking for an established growth stock in the tech space, or a relatively safe investment in the face of an often volatile U.S. stock market.

About The Company: Cisco Systems Incorporated is a leading provider of Internet Protocol-based networking and other products for transporting data, voice, and video across geographically dispersed local-area networks, metropolitan-area networks, and wide-area networks. Devices are primarily integrated by Cisco IOS Software and include Routers, Switches, New Products, and Other. Provides services associated with these products.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.